Discovery: Well-Positioned To Meet Evolving Consumer Demand
Summary
- Discovery's revenue from advertising and distribution has grown consistently since 2014, both in the US market and the International market.
- Discovery's increasing use of the digital platform to provide content gives an opportunity to capture a growing commercial market.
- While advertising revenues may be deferred due to show cancellations from COVID-19, Discovery has managed to create new content that resulted in Top Ratings across its network channels.
- We estimate Discovery's fair value to be ~USD 36 (44% upside from the current level).
Media companies that provide content through linear platforms are experiencing a decline in viewers and subscribers. Even among major media conglomerates, the hype is all related to their digital platforms. However, one particular company is in a good position to ride the wave of transition from linear networks to direct-to-consumer ("DTC") subscription products. That company is Discovery Inc. (DISCA).
Number of subscribers among major brands (Millions):
Consistent Revenue Growth while keeping costs the same
DISCA generates revenue mainly from sales on advertising on its networks and fees from contracts with cable and satellite operators as well as digital service providers for distributing its network content. Advertising and Distribution revenues grew every year for the last 4 years, both in the US and International markets. Following a successful acquisition of Scrips Networks Interactive in 2017, DISCA was able to offset the subscriber loss in its Discovery Legacy portfolio. Over the last few months, DISCA has been raking in TV ratings garnering new viewers among its core demographic audience. Considering advertising price and distribution fees depend on audience satisfaction level or ratings as well as the number of viewers, DISCA can use their performance ratings to demand higher fees.
Source: Discovery Corporate Newsroom
Revenue by Segment and Geography (US Bn):
Despite decreasing demand in linear TV as shown by the decreasing number of subscribers across its network, DISCA still maintains profitability by leveraging its lower cost production model. DISCA's advertising expenses are captured as selling, general, and administrative costs, whereas distribution cost or COGS primarily derives from content expenses including production.
Flexibility in Digital Platforms Integration
Discovery's increasing utilization of digital platforms to expand reach for advertisers shows versatility in a declining industry, while still maintaining a great partnership with their distributors. DISCA provides existing networks and channels using its distribution relationship with Cable TV providers in platforms such as DirectTV Now, AT&T Watch, Hulu, SlingTV, fuboTV, and YouTubeTV. Moreover, DISCA's current streaming portfolio comprises DPLay, MotorTrend, and Discovery Go. Earlier this year, the media company struck a one-year partnership with Amazon to distribute Food Network Kitchen on FireTV, which has tens of millions of subscribers, at no additional cost for FireTV subscribers. Lastly, we expect Discovery to launch a new global streaming service providing BBC natural history shows following Discovery and BBC's 10-year content partnership since 2019.
Going Forward (Risks and Potential)
Discovery's major risk includes decreasing advertising revenue because fees are either paid upfront or scatter (after the advertisement is aired or close to air-date). With COVID-19, this posed an uncertainty as many revenues are deferred. However, DISCA can use its higher network ratings in TLC, Food Kitchen, and HGTV as leverage to demand higher fees as proven historically. Given its ability to flex cost structure, DISCA is well-positioned to mitigate shortfalls caused by a recent pandemic.
As for distribution, DISCA's CEO mentioned in Q1 Earnings Call:
We recently completed distribution renewals with some key partners in the US for carriage of all of our channels. There was a time when many questioned whether, in our renewals, we would be able to include all of our channels. We have, which underscores the value of our characters, our programming, and most importantly, our brands."
According to the company's 2019 10-K, DISCA has a partnership with the largest 10 distributors in the US, with contracts up to 2024. Thus, the renewal announcement provided a sense of stability in the Distribution Segment. In the earnings call, it was stated that Q1 2020 was the first quarter having its content fully displayed on Hulu and SlingTV. Therefore, we expect a stable growth in distribution revenue in the following four years.
Next, the arrival of live sports across Europe is a positive relief for Discovery. With matches played behind closed doors, DISCA is in a position to benefit from increasing viewers on its Eurosport Channel. Discovery also holds rights to the Olympic Summer Games in Tokyo 2020. As the event is postponed to next year, DISCA has the opportunity to build its DTC platform for potential viewers and sports enthusiasts.
Valuation
We projected Discovery's revenue to be growing at 10% CAGR from '20-24 FY and EBITDA to grow at 15% primarily driven by increasing advertising and revenue growth and relatively low cost in non-fiction content production.
Our DCF analysis using 7.87% WACC, 1% terminal growth, and 10.8x EV/EBITDA which is in line with the competitor's median multiple resulted in an implied fair value of USD 36.7-38; a 44-48% upside from the current level. We believe the potential upside is an attractive investment opportunity given DISCA's flexibility in adapting to a changing media industry as well as its consistent revenue growth.
DCF based on terminal growth rate:
DCF based on EV/EBITDA rate:
This article was written by
Analyst’s Disclosure: I am/we are long DISCA. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.
Recommended For You
Comments (18)
Apple could use Discovery too
